Proposals for controlled foreign companies (CFC) reform

Comments from ACCA to HM Treasury and HM Revenue and Customs (HMRC), April 2010.

ACCA is pleased to comment on the proposals for reform of this complex and important area of UK tax legislation and policy. ACCA acknowledges the value of continuing dialogue and feedback in this area.


ACCA agrees with the stated aim of the consultation document that the new regime should as far as possible minimise compliance costs and seek to provide taxpayers with certainty. The approach of HMT and HMRC to this consultation is welcomed. The declared intention of using the new CFC rules to improve competitiveness, generate economic growth, jobs and ultimately therefore tax revenues in the UK will be particularly appreciated by business. The consultation process has involved businesses and other interested bodies from an early stage, and this has borne clear benefits in the state of the proposals at this point.

However, there are still areas where some work is needed to transform the proposals from broadly popular and acceptable concepts into practical and enforceable legislation. There are three main areas of potential concern.

Firstly, the new regime may still not go far enough. Many foreign jurisdictions have systems which remain simpler and more attractive to multinationals. It is too late for this set of reforms to scrap the CFC regime altogether and move to a Targeted Anti-Avoidance Rule (TAAR) for specific abuses such as cashbox companies lending upstream. Consideration should be given to such a move in the future, with due regard for developments in EU law in this area.

Secondly, the filter tests may still add extra complexity without the appropriate benefits. The balance here is hard to strike, but those businesses with genuinely simple affairs will derive only administrative burdens from complex filters. Meanwhile, the needs of those whose fact patterns are more complicated are likely to be better served by having their affairs reviewed by an experienced and knowledgeable tax inspector than completing a minutely detailed box ticking exercise. The use of case by case analysis in difficult areas certainly meets the aim of fairness more fully than mechanical filters.

Thirdly, the EU law compliance of the new regime will be fundamental, and yet this is barely touched upon in the consultation document. We have addressed this matter in more detail below, but believe that views should be actively canvassed from as wide a range of advisers as possible to minimise the risk of lengthy and costly litigation once the new regime is in place.

There is one final area of concern for ACCA, which does not relate directly to the proposals within the consultation document, but rather to how they will fare in the UK once enacted. Multinationals hate uncertainty. HMRC must resist the temptation, once the new rules are in force, to retrospectively alter them if taxpayers disagree with HMRC’s interpretation of them. To do so would be to send completely the wrong signals about the stability and reliability of the UK tax system to multinational groups.

Overarching framework

Turning to the more specific areas covered by the consultation document, ACCA agrees that the continuing exclusion of capital gains from the CFC rules will be beneficial. It promotes simplicity, and avoids the distortive nature of one-off capital gains.

The current proposals envisage a blend of mechanical filters, which will give businesses a degree of certainty as to whether their transactions will fall without the provisions of the regime, combined with a ‘backstop’ intention test, thereby blending the best features of the mechanical process (certainty) with the intention based testing (fairness). This seems to be an increasingly popular form of regime to combat tax avoidance, and one which appears currently to offer the best blend of equity and utility. When considering the issues of filters, white-lists and EU compliance, the suggestion that a new filter could be based on statutory tax rates certainly represents a welcome simplification. The suggestion for further filters based on particular types of tax system, or use of UK style tax computations, may however start to create more complexity of just the type that HMRC and HMT are trying to avoid.

There are also significant concerns, shared by some of our members, that any statutory tax test would not be EU compliant. Following the ECJ’s decision in the Cadbury Case (C196/04) any company genuinely established in the EU is arguably outside the scope of the existing rules, and potentially outside the scope of the new rules which clearly restrict the freedom of establishment by adding a further UK tax and administration burden in respect of overseas subsidiaries that would not exist in the UK. The suggestion has been made that the new rules should simply exclude all companies genuinely established in the EU in order to avoid potential litigation. However, ACCA does not believe that this is necessary, nor does ACCA think that it would coincide with HMT’s preferred approach.

The recent case of SGI v Belgian State (C-311/08) has provided a timely update on the evolution of the ECJ’s jurisprudence in the area of tax avoidance legislation in the EU. It is now clear that a restriction on the freedom of establishment (such as a CFC regime) may be justified not only where rules are aimed at wholly artificial arrangements designed to circumvent the legislation of the Member State concerned, but also where the justification of the rules is the prevention tax avoidance ‘taken together with… preserving the balanced allocation of the power to impose taxes between the member states’. The UK must of course remain alert to the possibility of creating double taxation, but the proposed initial filter mechanisms should reduce this risk. Allowing relief for taxes suffered in the entity receiving the advantage would eliminate the possibility of double taxation altogether, ensuring that even within an EU context the rules would remain valid.

Furthermore, the SGI judgment indicates at paragraph 68 that the prevention of practices based on ‘significant disparities between the bases of assessment or rates of tax applied in the various member states and designed only to avoid the tax normally due in the Member State in which the company granting the advantage has its seat’ can justify the breach of the fundamental freedom. This would appear to give the green light to white list tests based on ‘significant’ differences in tax rates or bases. Accordingly, the proposed new test should be compliant with EU law, provided that any taxpayer caught has the opportunity to offer a defence such as the proposed motive test discussed below.

There are several areas of the motive test that merit comment. The first of these is the incidental income exemption, which is in principle a welcome element of the rules. The level of ‘incidental’ should be defined by reference to turnover, rather than trading profits, so as to avoid potential short term volatility. As suggested in the consultation document, local legal requirements should be taken into account, with an exemption for eg interest income arising on cash that cannot be repatriated to the UK for overseas tax or exchange control reasons. The motive test should also include scope to potentially exempt companies where trading has been permanently reduced or discontinued but there has been a delay in liquidating the company or otherwise extracting the cash.

ACCA welcomes the statutory confirmation of HMRC’s informal practice of allowing a grace period for newly acquired companies. Again, this is a step which promotes clarity and certainty for multinational companies, meeting the declared aim of making the UK’s tax system more competitive.

Monetary assets

Considering now the two main areas of corporate activity in which the UK is seeking to protect its tax base, ACCA has a number of points of general policy to raise. The proposals to restrict the application of the new regime to financing operations as distinct from treasury operations is welcomed. It would be even more helpful if qualifying treasury companies were permitted to advance long term loans intra-group. In practice most treasury centres lend and borrow long term as well as short term. If the company makes only a small turn, as the paper suggests, then the scope for tax avoidance is limited.

The proposed safe harbour funding ratios for general finance companies are also helpful. While calculation of restriction by reference to funding levels of the finance company may lead to a degree of artificiality, with companies tending to operate at the higher end of the limits imposed by the safe harbour ratios, the certainty thus provided would offset the potential distortion of funding bases. HMRC has traditionally taken a very prudent approach to thin capitalisation for inward investors, insisting for example on ongoing interest cover as well as a low structural debt:equity ratio, and we should expect a consistent approach here.

The Treasury is concerned that financing companies in countries offering a low tax regime could be equity capitalised and lend the funds back upstream to the UK. However, the safe harbour for finance companies, the unallowable purpose test and the UK debt cap rules should between them eliminate the potential tax advantages without the need for further specific interest disallowance rules.

Intellectual property

The first area of concern raised in the intellectual property arena is transfer of IP from the UK. While ACCA welcomes the Treasury’s recognition that overseas ownership and management of IP may not be intended to avoid UK tax, the paper suggests it could be difficult to eliminate UK nexus altogether. UK listed and headquartered groups tend to impose on their subsidiaries some strategic direction of IP management, along with strategic direction in all other areas of business. They may also centralise some maintenance of IP in the UK, either within the group or using a third party UK IP agent. The law should recognise that if these functions are suitably remunerated, the overseas IP owner should not be treated as a CFC. It would be ironic if a side-effect of the new rules, intended to improve UK competitiveness, was a transfer of IP maintenance activities overseas.

When IP does leave the UK, the discussion document proposes an exit tax on an earn out basis. Such charges are in principle objectionable to EU law, and must be justified to remain compliant. Moreover, they introduce uncertainty and extra cost for business, without any apparent facility to recognise the possibility that the IP may subsequently prove to be worthless, or that increases in value might actually be attributable to the knowledge and expertise of the recipient company, and impossible to replicate had the IP remained in the UK. ACCA believe that the problem of earn-out charges could potentially be avoided by introducing a targeted rule applying the principles of the SGI case above. Where the transfer of the IP is to any extent ‘gratuitous’, then its effect would be nullified and the income arising from that IP would simply be retained with the donor company’s UK tax base. There would be no need to retain the exit tax structure at all, as for tax purposes there would be no exit. While there may be a need to consider the level of expertise required for management of IP at different stages in its lifecycle to determine the level of gratuity, the system would be EU compliant, and would not commit groups to paying tax on income that may never arise. A complementary measure would be to widen the scope of the proposed patent box, in order to encourage groups to retain IP in the UK, or even to transfer it in.

The proposals for IP already held outside the UK raise slightly different issues. The ‘filter’ test of active management will inevitably be harder to operate than the jurisdiction level filters on tax system etc, as there will be far more subjective judgment involved. ACCA is also concerned that the system may come to resemble the complexity and formality of the case law based ‘central management and control’ test for company residence, but operated on an asset by asset basis. Consideration should be given to a de minimis test specifically for IP income in this context. Nevertheless, ACCA would hope that a workable system can be developed, and welcomes this move on the part of the UK tax authorities to recognise the economic realities of how multinational groups operate.


ACCA welcomes the broad thrust of the proposals. A system which clearly identifies the extent of a group’s UK tax base would provide certainty and remove the incentive for company’s to distort their investment profiles for tax reasons. The new proposals have been formulated in conjunction with business, the professions and representative bodies and as a result have been closely targeted on those areas perceived to pose the greatest risk of abuse. It would be helpful now if HMT and HMRC could take on certain points of detail to make the system workable. Any CFC regime will involve some complexity, but the restriction of the complexity to the smallest number of areas is to be welcomed.